If you’ve been watching the stock market, you’ve undoubtedly noticed a fair amount of volatility in recent weeks. At its low, the Dow Jones Industrial Average was down by more than 10%, leading some in the news media to label this as a “correction.”
While I don’t view the financial markets as being any more or less “correct” since the selloff, I realize that many investors may be concerned about the sudden volatility in stocks. As such, I’d like to suggest a few thoughts about recent market activity.
- The heart of the matter is actually a good economy. The February labor report by the US government reflected unexpected wage growth in the economy. Rising wages can lead to increasing inflation. It can also lead to higher interest rates, which elevates borrowing costs for corporations and makes capital more expensive to raise. Ultimately, this could limit the rate of future growth in the economy.
- As investors, we’re stakeholders, not speculators. Keep in mind that stock ownership is actually a claim on the future earnings of the companies we own. No matter what the markets are doing, consumers still fly airlines, put fuel in their cars, drink Coca-Cola and buy Apple computers. Even if stocks are valued less today, the long-term increase in your wealth is tied to how those companies grow their earnings, not to how much your stock is worth on a given day.
- Historically, stocks have been good hedges against inflation. Though unanticipated inflation can cause stock prices to drop unexpectedly, corporations are often able to pass rising costs onto their customers. Over time, those higher prices translate into increased earnings and dividends that keep pace with inflation, allowing your portfolio to preserve its purchasing power. This is in contrast with most bonds, which have no inflation protection.
- Don’t base investment decisions on the recent past. A sudden decline in stock prices can be worrisome, but the past provides little insight into the future direction of stocks. This is because all relevant information has already been reflected in the financial markets. Though we can attempt to forecast where the economy is headed, the markets have likely priced those expectations into stocks and bonds as well. The only things not reflected in prices are future news and events, which are unknown.
- Even when CNBC is bearish in stocks... On any given day, financial markets operate in a state of constant equilibrium. Sellers and buyers who have access to the same information trade securities at agreed prices. The seller who wants to get out of the market is met by an equally informed buyer who thinks she is making a good investment. Regardless of the present outlook, not even the “experts” on CNBC can foretell the future direction of stock prices.
- Doing nothing is sometimes better than doing something. In many cases, realized returns are highest when expectations are low. Attempting to time the markets in response to a pesimistic forecast can cause you to miss out on a rebound and limit the success of your strategy. Rebounds come unexpectedly and missing only a few days of strong returns can drastically impact overall performance.
Because successful investment strategies are intended to help you build wealth over time, I find that it’s beneficial to have one that you can live with in all kinds of markets. Capital markets reward investors with a return that’s commensurate with risk, but those returns take time and patience to realize.
Robert Ades, CFA